Comment

Supply of government paper hit the market in full force last week and the market found no place to hide. The government auctioned Rs 23,000 crore of dated bonds and treasury bills under the government borrowing program and under the MSS (market stabilisation scheme).

The market, under increased pressure from higher trending inflation and increased supply of government paper, bid up yields at the auctions. The Reserve Bank of India (RBI) gave the bonds at the levels at which the market bid. The auction cut-offs pushed up the yield curve while flattening it.

This week will see the government auctioning Rs 11,500 crore of paper of which Rs 10,500 crore is under MSS. It will also announce Rs 10,000 crore of dated bond auctions under the regular borrowing program. The high supply of paper before the RBI annual monetary policy on April 29 will push up yields further as the market expects the RBI to hike rates to control surging inflation.

The MSS bond auction of 6.57% 2011 bond for Rs 5,000 crore last week saw the cut-off coming in at 7.95% levels. The high cut-off indicates the markets nervousness on the short end of the curve and the increased expectations of rate hike in the monetary policy.

The government bond auction of 7.38% 2015 for Rs 6,000 crore and 7.95% 2032 bond for Rs 4,000 crore saw the cut-offs come in sharply higher as the inflation numbers released for week ended March 29, 2008 came in much higher than expectations.

Inflation as measured by the WPI (wholesale price index) came in at 7.41% against market expectations of 7.03%. The cut-off on the 7.38% 2015 bond came in at 8.14% levels against market expectations of 8.10% levels. The bond was trading at 7.95% levels before the auction. The cut-off on the 7.95% 2032 bond came in at 8.67% levels against market expectations of 8.70% levels. The bond was trading at 8.55% levels before the auctions.

The long-bond cut-off at better than market expectations indicates good investor interest though the next auction may see negative cut-off, given the proximity to the monetary policy date.

The RBI has announced auctions worth Rs 11,500 crore for this week. The RBI is auctioning dated securities under MSS for Rs 3,000 crore. Auctions worth Rs 8500 crore of T-bills include Rs 7500 crore under MSS. The short end of the curve will remain under pressure given the supply.

Liquidity was high in the system with bids for reverse repo touching all-time highs. Liquidity as measured by bids for reverse repo repo in the liquidity adjustment facility (LAF) of the RBI saw bids for reverse repo touching Rs 79,000 crore last week.

Overnight rates were trading at lower levels on easy liquidity, with call and repo rates at 5% to 5.5% levels. Liquidity is likely to be easy and overnight rates will trade below 6% levels.

Government bonds
Government bonds saw yields move up week on week. The yield on the benchmark ten-year bond 7.99% 2017 closed higher by 4 bps at 8.02% levels. Five-year benchmark bond yields was higher by 15 bps with the yield on the 7.27% 2013 paper closing at 8% levels.

Yields on the long bond, the 8.33% 2036, closed higher by 7 bps at 8.63% levels. The ten over thirty spread closed higher by 3 bps at 61 bps levels.

The RBI has announced dated government bonds auctions worth Rs 3,000 crore for this week. The bond to be auctioned under the MSS is the 6.57% 2011 bond for Rs 3,000 crore. The auction cut of is likely to be close to last week’s cut off of 7.95%. There are no auctions under the regular borrowing program scheduled for this week, though the auction announcement of Rs 10,000 crore scheduled for the period April 18-25 is expected on April 17.

Treasury bills, corporate bonds and overnight index swaps
Treasury bill (T-bill) yields were higher last week on increased supply. The cut-off at the 91-day T-bill auction on April 9 came in at 7.23% against a cut off of 6.94% seen in the previous auction. The 364-day T-bill auction saw the cut-off at 7.37% against a cut-off 7.35% seen in the previous auction.

The RBI is auctioning Rs 5,500 crore of 91-day and Rs 3,000 crore of 182-day T-bills this week of which Rs 5,000 crore of 91 day and Rs 2,500 crore of 182-day T-bills is under MSS. T-bill yields are likely to move higher given the increased supply.

Corporate bonds saw yields move up across the curve as cut offs of government papers came in negative. Five-year yields were trading in the 9.45% to 9.55% range, up 10 bps week on week. Five-year AAA bond spreads were lower by 8 bps week on week at 140 bps levels as government bond yields rose. Corporate bond spreads are likely to rise as RBI sucks out liquidity through auctions.

Overnight index swaps (OIS) saw the swap curve rise on interest rate concerns. One-year OIS yields moved up by 10 bps to close last week at 7.30% levels while the five-year OIS yields closed higher by 8 bps at 7.42% levels. The one over five spread flattened by 2 bps from 14 bps levels to 12 bps levels. OIS yields are likely to remain pressured on rate hike fears.

The author is head, portfolio management services, Sundaram BNP Paribas AMC Ltd. The views expressed by the author are his own and need not represent the views of the organisation in which he works.